China’s bid to lock in cheap iron ore

Who's eyeing Fortescue Metals?
Who's eyeing Fortescue Metals?   

With iron ore prices still at multi-year lows, a reported interest by China's biggest steelmaker for indebted Australian iron ore miner Fortescue Metals makes business sense for both parties, depending on how much the deal is worth, analysts say.

"It's logical that Baosteel would try to secure future supply," Patersons Securities' director of research Robert Brierley told CNBC. But "I doubt Andrew (Forrest, Fortescue Group's chairman) would sell at these prices," he said.

Iron ore prices may be staggering back from 10-year year lows, but the biggest customers appear to be seeking to lock in the cheap prices by going straight to the source – and buying the miners.

China's Baosteel and CITIC, a Chinese conglomerate, have applied to Australia's Foreign Investment Review Board (FIRB) for permission to recapitalize Fortescue, reported the Australian Financial Review late on Monday.

In a statement to the Australia Stock Exchange, Fortescue said it "does not comment on speculation. Fortescue is not aware of the FIRB applications by third parties." When contacted by CNBC, the Australian Treasury, which runs FIRB, declined to comment.

Despite the statements, Fortescue's shares soared on Tuesday by as much as 15 percent and were trading up 8.99 percent in mid-day Asia trading time.

The company's stock has trailed the decline of iron ore prices: since the beginning of 2014, Fortescue's shares have dropped 58 percent while iron ore prices have fallen by 56 percent.

Close relationship

Baosteel's bid for Fortescue should not come as a major surprise because the China's biggest steelmaker is the Australian miner's biggest customer, analysts said.

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Fortescue, which produces 11 percent of the world's iron ore, almost exclusively supplies China – and 63 percent of that "is believed to go to Baosteel," according to Patersons Securities' Brierley.

Still, struggling with low iron prices and a huge debt pile, Fortescue could do with an injection of some capital, noted analysts.

Fortescue had a total debt burden of $9.6 billion at the end of 2014 and has struggled to manage its debt pile, withdrawing one bond issue in early March only to replace it a month later with a bond paying a much higher interest rate.

On March 18, Fortescue abandoned plans to issue $2.9 billion worth of bonds at between 6 and 8.25 percent; on April 23, the company did raise $2.3 billion from a bond issue, but with an interest rate of 9.75 percent.

"Fresh capital would be very welcome and put them on equal footing with BHP Billiton and Rio Tinto," Motley Fool's resources analyst David Lennox told CNBC.

Just the beginning

Whatever happens to this rumored bid, more of them are likely on the way, analysts said.

Australia has enjoyed a decade-long mining boom and the current slump "is a chance to rationalize the industry," National Australia Bank's senior Asia economist Gerard Burg told CNBC by phone.

And more Chinese companies are likely to seek to lock in the currently low prices.

"It's the nature of the business – China still produces half of the world's steel," he said. In the longer run, more companies from China, and eventually, India, are expected to form partnerships with Australian miners, particularly in the iron ore and coal sectors, he added.

What should not change is that emerging market countries will keep on needing natural resources to build new infrastructure.

"Iron ore and all the other commodities that seem to be in the dumps right now will always be in demand," said Vedanta Resources' CEO Tom Albanese told CNBC.